Pakistan continues to face economic,
political and security challenges, which are likely to hinder foreign direct
investment (FDI) in the country. Almost all sectors of the economy are under
severe stress due to weak economic growth. The three main sectors- the telecom,
power, and finance have already lost attraction due to terrorism, which shook
the confidence of both the local as well as foreign investors.

Analysts believe that mounting
terrorism inside the country is expelling foreign investors from the country
while causing massive losses to manufacturing and trading sectors.

The FDI dropped by 52 percent during
July-November period of current fiscal year due to power shortage, worst law and
order situation and uncertainty on political front. FDI reduced to $774 million
in July-November of current fiscal year as compared to $1.62 billion in same
period of last fiscal year, depicting a decrease of $846.7 million. However,
portfolio investment, which was on decline during last fiscal year, posted a
surge of 291 percent due to some profit taking in the equity market.

Portfolio investment mounted to $311.3
million in July-November relative to a negative position of $162.9 million in
corresponding period of last year.

A political crisis is raising head in
the country, as President Asif Ali Zardari is facing calls to step down after
the Supreme Court struck down an amnesty that had protected the increasingly
unpopular leader and several of his political allies from corruption charges.

November was the third consecutive
month in which the country posted decline in foreign direct investment (FDI) due
to worst law and order situation. Rising political uncertainty has cost the
country's stock markets dearly in the shape of outflow of foreign investment in
December that was otherwise showing encouraging signs in the previous months.
The experts believe that the inflows would further decline in the coming months
as new development on political front has started taking strong grip over the
country. Market players are anxious over the uncertain political situation and
its fallout on the economy and stock business.

The double-digit inflation has pushed
more people below poverty line in the absence of any significant economic
activity owing to prevailing law and order situation in the country.

National Reconciliation Ordinance (NRO)
was promulgated by former president Pervez Musharraf as a result of a
US-brokered deal that allowed former Prime Minister Benazir Bhutto to return
home from self-exile and participate in politics without facing charges. Under
the deal, corruption investigations involving up to 8,000 ministers, bureaucrats
or politicians from across the spectrum were stopped.

After the assassination of Benazir
Bhutto in December 2007, her husband Zardari provided leadership to the Pakistan
Peoples' Party (PPP) and was elected the country's president last year after the
Musharraf's resignation. Zardari is facing several corruption cases including
the alleged misappropriation of $1.5 billion and an alleged multi million-dollar
money laundering case.

The uncertainty regarding corruption
cases against some sitting ministers, advisors, and members of parliament has
created uncertainty among the investors. The benchmark Karachi stock exchange (KSE)
100 Index so far witnessed a net outflow of $6.279 million in December. The
absence of any leverage product for the last many months has already hampered
the entry of local as well as foreign funds in a big way.

The country was also unable to grapple
the situation arisen because of global financial crisis and only a few countries
found Pakistan attractive for portfolio investment.

Investors are cautious of the future
impact of post-NRO scenario, and have decided to keep an eye on day-to-day
developments before resuming normal operations.

The country's economy is already paying
the heavy costs of fighting terrorism. Islamabad launched its largest offensive
against Taliban militants in October by sending 28,000 troops into South
Waziristan, the tribal area in the country's northwest. The U.S. wants Islamabad
to extend its campaign against Islamist extremists, but the rising political
tensions in the country is not only harmful for the country's economy, which is
presently in recovery phase, but it may also affect the authorities'
administrative capabilities to effectively deliver vis-‡-vis war on terror.

Mainly the policies of the government
bring foreign investment in a country.

The policies of liberalization,
deregulation and privatization of the former government resulted in rapid growth
of all segments of the economy particularly telecom and banking sectors. These
policies paid rich dividends.

The reforms implemented under former
government however lacked strategic policy coherence. The heavy outflow of the
portfolio investment during July-January 2007-08 lowered the growth of FDI,
which had increased by 7.9 per cent during the same period a year ago. The
country had received $669 million portfolio investment during July-January
2006-07, but it received only $21 million during the same period a year ago.

In order to attract foreign investment
in the country, the former government of Prime Minister Shaukat Aziz had allowed
the foreign companies to repatriate100 percent profits to their owners abroad.
But this policy proved short-sighted, as it attracted the foreign capital for a
short time period to meet the country's trade and current account deficits, but
failed to lower the cost of doing business and prepare a skilled workforce in
the country.

Pakistan had attracted $1.524 billion
FDI during the fiscal year 2004-05, which was 61 per cent higher than the
corresponding period of 2003-04. This also included $363 million FDI as
privatization proceeds of 10 per cent first tranche of PTCL and $103 million
second tranche of Habib Bank's privatization. In 2004-05, the portfolio
investment from US amounted to $47 million, up from $21 million the previous
year and higher than from any other country. The country's total foreign
investment witnessed a growth of 50 percent at 6.282 $billion during 11 months
of last fiscal year 2006-07 against $4.177 billion of the fiscal year 2005-06.

In 2006-07, USA was on top with $1.544
billion investment, while UK with $1.139 billion was the second. UK and USA
share in total foreign investment (FDI and portfolio investment) in 2006-07 had
increased by $1.795 billion to $2.683 billion as compared to $888 million in
fiscal year 2005-06.

The beginning of the last fiscal year
2008-2009 had however been encouraging with respect to FDI inflows that recorded
an increase of 76 per cent in the first month. FDI inflows were at $340 million
in July 2008, according to the State Bank of Pakistan. The telecommunication
sector received the lion share of $147.7 million in the month under review as
against the $27.2 million in the same month last year. The financial sector
received $43.4 million in July 2008 against $28 million the same month last
year. Oil and gas exploration sector attracted $37 million in FDI in July 2008.

Today, political instability, civil
conflicts and law and order are the major factors in reducing the attractiveness
of Pakistan as a host for foreign capital. The present government needs to
improve its economic conditions and policy framework and ensure improved
governance to attract sizable foreign investment. The improvement in
infrastructure and the rule of law is direly needed. There also exists a
considerable room for legislative and regulatory reforms particularly at the
provincial level. Saudi Arabia, USA, UK, and China can still be a major source
of investments into the country. The main challenge for Pakistan is to keep up
with reforms in many developing countries.